Gunboat Diplomacy

Political Bias, Trade Policy, and War

Brendan Cooley

13 March 2019

Trade and War: Received Wisdom

“Free trade serves the cause of economic progress, and it serves the cause of world peace.”
$\qquad$ – Ronald Reagan, Nov. 1982

“Commercial relations draw states into a web of mutual self-interest that constrains them from using force against one another.”
$\qquad$ – Oneal and Russett (1999)

Dominant Paradigm: Trade mediates preexisting conflicts of interest

Conflicts of interest: territorial, ideological, otherwise
War disrupts trade, imposes opportunity costs

Trade and War Onset

Gunboat Diplomacy

Examples

Perry Expeditions (1852-1854)
Opium Wars (1839-1842; 1856-1860)
Euromaidan and War in Donbass (2014-present)

Commercial Policy Objectives

Governments are mercantilistic, desiring
- Some degree of trade protection at home
- Trade liberalization or market access abroad

Market Access Externalities

Protectionist barriers shift profits from foreign to home firms
Trade policy generates conflicts of interest between mercantilist governments

International Anarchy

Efforts to address externalities can include threats, displays, and uses of military force
- Bargaining critique (Fearon 1995): absence of war does not imply absence of coercion

A Theory of Trade Policy in the Shadow of Power

Model

“New Trade” International Economy
- Krugman (1980), Venables (1987); Ossa (2012)
Mercantilist/Politically-Biased Governments
- Grossman and Helpman (1994), Bueno De Mesquita et al. (2003), Jackson and Morelli (2007)
- Liberal governments afford consumers greater influence over the trade policymaking process
Ultimatum Coercive Bargaining
- Fearon (1995)

Results

Trade and Conflict
- Liberal governments experience smaller conflicts of interest (Proposition 3)
- “” fight war less frequently (Proposition 4)
- “” trade more when peace prevails (Proposition 5)

Trade Policy in the Shadow of Power
- Trade policies reflect balance of military power, powerful countries more protectionist in equilibrium (Proposition 6)

Trade and peace are correlated, but not because trade causes peace

Literature

Bargaining Environment

“Home” ($i$) government makes TIOLI trade policy offer to “foreign” ($j$) $\widetilde{\boldsymbol{\tau}} = \left\{ \widetilde{\tau}_i, \widetilde{\tau}_j \right\} \in [1, \bar{\tau}]^2$

Foreign accepts or rejects
- Rejection results in war for regime change

Information about $j$’s costs of war ($c_j$) held privately, distributed $f(c_j)$

Definition 1: A subgame perfect bargaining equilibrium is pair of strategies, $\widetilde{\boldsymbol{\tau}}^\star(a_i, c_i)$ and $\omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j)$ such that \[ \omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j, \rho) = \text{argmax}_{\omega \in \left\{\text{accept}, \text{war} \right\}} \widetilde{G}_j \left(\widetilde{\boldsymbol{\tau}}, \omega; a_j, c_j, \rho \right) \] and \[ \widetilde{\boldsymbol{\tau}}^\star(a_i, c_i, \rho) \in \text{argmax}_{\boldsymbol{\tau} \in [1, \overline{\tau}]^2} \mathbb{E}_{f(c_j)} \left[ \widetilde{G}_i \left(\widetilde{\boldsymbol{\tau}}, \omega^\star(\widetilde{\boldsymbol{\tau}}; a_j, c_j, \rho); a_i, c_i, \rho \right) \right] \]

$\widetilde{G}$ government utility
$\rho \in [0, 1]$ probability $i$ wins war (military strength)

Domestic Political Economy

Government Preferences

\[\begin{equation} \label{eq:G} G_i(\tau_i, \tau_j | a_i) = a_i V_i^x(\tau_i) + \Pi_i(\tau_i, \tau_j) + r_i(\tau_i) \end{equation}\]

$V_i^x(\tau_i)$ - consumer welfare
- decreasing in $\tau_i$
$\Pi_i(\tau_i, \tau_j)$ - firm profits
- increasing in $\tau_i$, decreasing in $\tau_j$
$r_i(\tau_i)$ - tariff revenue
- non-monotonic in $\tau_i$

$a_i$ is measure of government’s sensitivity to interests of consumers

Assumptions

International Economy

Representative consumer and $n$ firms in each economy, monopolistic competition
- Krugman 1980, Venables 1987, Ossa 2012

Economy

Government Preferences I

Government Preferences II

Results

Noncooperative Equilibrium

Definition

Conflicts of Interest and Regime Change

Optimal Puppet Regimes

When a government wins a war, it earns the right to replace the vanquished government with a “puppet” that prefers lower barriers to trade

\[ \max_{a \in (0, \overline{a}]} G_i( \tau_i^\star(a_i), \tau_j^\star(a) | a_i ) \]

Losing governments have puppet’s policies imposed on them

Conflicts of Interest

Utility difference between (costlessly) winning a war for regime change and being replaced by a puppet

\[\begin{equation} \label{eq:Gamma} \Gamma_i(a_i, a_j) = \overline{G}_i(a_i) - \underline{G}_i(a_i, a_j) \end{equation}\]

Proposition 3: $\Gamma_i(a_i, a_j)$ is decreasing in $a_i$, $a_j$

Bargaining Environment

Bargaining

Results

Trade and War

Proposition 4: In a bargaining equilibrium (Definition 1), the probability of war is weakly decreasing in $a_i$ and $a_j$.

Proposition 5: In a peaceful bargaining equilibrium (Definition 1), trade is weakly increasing in $a_i$ and $a_j$.

Results

Trade and War

Proposition 4: In a bargaining equilibrium (Definition 1), the probability of war is weakly decreasing in $a_i$ and $a_j$.

Proposition 5: In a peaceful bargaining equilibrium (Definition 1), trade is weakly increasing in $a_i$ and $a_j$.

Shadow of War in Trade Policy

Proposition 6: In a peaceful bargaining equilibrium (Definition 1), government $i$’s trade barriers are increasing in its military strength. $\tilde{\tau}_i^\star(a_i, c_i, \rho)$ is increasing in $\rho$.

Implications

Preferences, Institutions, and the Democratic Peace

Hypothesis: Democracies more liberal in trade policy preferences than autocracies
- Democratic political institutions and consumer influence over policymaking (Mayer 1984; Grossman and Helpman 1996; Milner and Kubota 2005)

Conclusion: Democracies trade more, fight less
- Democratic peace: Oneal and Russett (1999), Reiter (2017)

Commercial-Democratic Peace

Shadow of Power in International Political Economy

Equilibrium trade policies balance
- Domestic political interests
- Foreign military constraints

Trade policies are not a sufficient statistic for government preferences
- Goldberg and Maggi (1999); Mitra, Thomakos, and Ulubasoglu (2006); Gawande, Krishna, and Olarreaga (2009); Gawande, Krishna, and Olarreaga (2012); Ossa (2014); Gawande, Krishna, and Olarreaga (2015)

Conclusion

Conflicts of Interest versus Bargaining Failures

Given a conflict of interest, what prevents peaceful settlement? (Fearon 1995)
What do governments want? and why do their objectives bring them into conflict with one another? (Moravcsik 1997)

Thank You

brendancooley.com

bcooley@princeton.edu

Title Slide Image Credit: Charles Severin (American lithographer, born between 1808-1820; died ca. 1860). 1853 (creation). The American Expedition, Under Commodore Perry, Landing in Japan, July 14, 1853, Overall view. visual works; prints (visual works); planographic prints; lithographs. https://library.artstor.org/asset/SS35100_35100_35234600

Trade and War Onset

$\label{fig:tradeRD}$

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Literature

Trade and War
- Angell (1911), @Polachek1980, Gowa and Mansfield (1993), Morrow (1999), Barbieri and Levy (1999), Mansfield and Pevehouse (2000), Gartzke, Li, and Boehmer (2001), McDonald (2004), McDonald and Sweeney (2007), Gartzke (2007), Benson and Niou (2007), Philippe, Mayer, and Thoenig (2008), Hegre, Oneal, and Russett (2010), Copeland (2014)
Power and Trade
- Hirschman (1945), Krasner (1976), Gourevitch (1978), Pollins (1989b), Pollins (1989a), Antràs and Padró i Miquel (2011), Chatagnier and Kavakli (2015), Carroll (2018)
Political Economy of Trade Policy
- Mayer (1984), Grossman and Helpman (1994), Kono (2008), Gawande, Krishna, and Olarreaga (2009), Ossa (2011), Ossa (2012), Ossa (2014)
Democracy and Trade
- Mansfield, Milner, and Rosendorff (2000), Milner and Kubota (2005)
Democracy and War
- Lake (1992), Snyder (1993), Oneal and Russet (1997), Schultz (1998), Oneal and Russett (1999), Schultz (2001), Fearon (2008), Coe (n.d.)

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Assumptions

Assumption 1: (costs of war are bounded) $c_i < \kappa$ where $\kappa$ is a postive constant defined in the Appendix.

Assumption 2: (agricultural sector sufficiently large)

\[ \alpha < \frac{2}{3} \frac{\sigma}{\sigma - 1} \]

Assumption 3: (governments are weak mercantilists) $a_i \in (0, \overline{a})$ with

\[ \overline{a} = (2n)^{\frac{1}{1-\sigma}} \left( \frac{\sigma}{\sigma - 1} + \frac{1}{2} \right) \]

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Economy

Consumption

\[\begin{equation} \label{eq:cMax} \begin{split} \max_{X_i, Y_i} & \quad X_i^\alpha Y_i^{1 - \alpha} \\ \text{subject to} & \quad P_i X_i + Y_i \leq w_i L \\ & \quad X_i = \left( n x_{ii}^{\frac{\sigma - 1}{\sigma}} + n x_{ij}^{\frac{\sigma - 1}{\sigma}} \right)^{\frac{\sigma}{\sigma - 1}} \end{split} \end{equation}\]

Production

$n$ firms producing differentiated goods and outside (agricultural) sector

\[\begin{equation} \label{eq:Pi} \begin{split} \max_{p_i} & \quad \Pi_i(p_i) = \left( p_i - w_i \right) \left( x_{ii}^\star(p_i) + x_{ji}^\star(p_i) \right) \\ \text{subject to} & \quad x_{ii}^\star(p_i) = p_i^{-\sigma} P_i^{\sigma - 1} \alpha w_i L \\ & \quad x_{ji}^\star(p_i) = (\tau_j p_i)^{-\sigma} P_j^{\sigma - 1} \alpha w_j L \end{split} \end{equation}\]

Revenue

\[\begin{equation} \label{eq:revenue} r_i(\tau_i) = n (\tau_i - 1) p_j x_{ij}^\star(\tau_i p_j) \end{equation}\]

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Government Preferences

Lemma 1: If Assumption 3 is satisfied, then $G_i(\tau_i; a_i)$ is quasiconcave on $\tau_i \in \left[ 1, \bar{\tau} \right]$.

Lemma 2: $G_i(\tau_j)$ is strictly decreasing in $\tau_j$.

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Noncooperative Equilibrium

Best Responses Functions

\[ \tau_i(a_i, \tau_j) = \text{argmax}_{\tau_i \in [1, \overline{\tau}]} G_i(\tau_i, \tau_j; a_i) \] and \[ \tau_j(a_j, \tau_i) = \text{argmax}_{\tau_j \in [1, \overline{\tau}]} G_j(\tau_i, \tau_j; a_j) \]

Definition 3: A noncooperative equilibrium is a pair of policies $\left\{ \tau_i^\star(a_i), \tau_j^\star(a_j) \right\}$ such that \[ \tau_i^\star(a_i) = \tau_i(a_i, \tau_j^\star(a_j)) \] and \[ \tau_j^\star(a_j) = \tau_j(a_j, \tau_i^\star(a_i)) \]

Lemma 3: $\tau_i^\star(a_i)$ is decreasing in $a_i \in (0, \bar{a})$ with $\tau_i^\star(\bar{a}) = 1$.

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Bargaining

Successful Regime Change

\[\begin{equation} \label{eq:Gbar} \overline{G}_i(a_i) = G_i(\tau_i^\star(a_i), \tau_j^\star(a^\star) | a_i ) = G_i(\tau_i^\star(a_i), 1 | a_i) \end{equation}\]

Foreign Imposition of Regime Change

\[\begin{equation} \label{eq:Gubar} \underline{G}_i(a_i, a_j) = G_i(\tau_i^\star(a^\star), \tau_j^\star(a_j) | a_i) = G_i(1, \tau_j^\star(a_j) | a_i) \end{equation}\]

Foreign Government’s Expected Utility for War

\[ \widehat{G}_j(a_j, a_i) = (1 - \rho) \overline{G}_j(a_j) + \rho \underline{G}_j(a_j, a_i) - c_j \]

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The Commercial-Democratic Peace

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